The Massive GameStop Short Squeeze, Explained

In this video, I break down what exactly a short squeeze is and why the GameStop short squeeze is so significant.

What's Going on w/ Gamestop

If you’ve paid attention to the stock market or Reddit or the news in the last few days, you may have heard a lot of talk about GameStop and a short squeeze. If you don’t really understand what’s happening or why, I’m going to try and break that down for you in this video.

Quick disclaimer: I am not a financial professional, this is not investing advice, and I am in a long position on GameStop at this time.

If the last time you thought about GameStop was when you tried trading in your Xbox 360 and 30 games, and you were only offered $20 in store credit and a bag of chips, well, some things have changed and some things haven’t.

Of course, mall retailers have been suffering the last several years and took an especially hard hit in 2020. It’s predicted that over 50% of department stores, which take up over half of the anchor space in malls, will close this year.

Where does that leave GameStop? Well, they are shutting down a lot of their underperforming brick and mortar stores and looking to focus more on digital. Ryan Cohen, who founded Chewy, the online pet retailer and sold it to PetSmart for 3.35 billion, took a 10% stake in GameStop in September of 2020, making him the largest individual shareholder… and then increased that to 12.9% in December. Now, Ryan and two former Chewy executives have seats on GameStop’s board, looking to turn the business model around.

So, if Ryan Cohen is able to make GameStop a bigger player in the higher-margin revenue world of ecommerce, this may take a floundering retail company on the brink of bankruptcy and turn things around in a big way.

So where does that leave us

Well, after hitting an all-time low in April of 2020 of $2.80, GameStop closed Friday at $65.01 after shooting up 51% that same day. It even hit a high of $76.76 on Friday, getting it’s stock halted for trading several times throughout the day due to how fast it was moving.

Why did all this happen?

Well, GameStop has more than 138% of its float shares sold short, which is the most shorted stock in the US Stock market. Let’s break that down further.

Float shares are the numbers of shares available for trading of a particular stock. So, well over 100% of these shares are sold short. What does that mean? It basically means wall street hates the stock and expects its value to fall. So, they borrow a stock, sell the stock, and then buy it back when the price drops. The price difference between what they sell it for and what they buy it back for is their profit. Essentially, if they sell GameStop at $20 and it falls to $5, they just profited $15. So, if someone thinks a stock is overvalued, they can try to profit when the stock drops in value.

Now, the thing with short selling is there is theoretically infinite risk, since there is no ceiling on how high the price of a stock can go. So, if GameStop somehow went to $200, the short seller who sold at $20, might have to buy back at $200 to exit their position, and they’d lose $180 doing so. And, if GameStop went to $1,000, short sellers would lose $980. So, in theory, there are infinite losses associated with short selling.

The other thing you may be asking is how can they short more than the share available?

Well, let’s scale things down for an example and say that GameStop issues only 150 shares. A fund wants to short the stock, so they borrow 100 shares and sell them to an institution. The institution does stock lending, and another fund comes along and wants to short 100 shares. This institution could lend them those shares to short, which means 200 shares are short out of 150 available. Over 130% of the shares are now short.

That’s kind of a silly example, but it illustrates how this can happen. It could be an endless cycle of borrowing and shorting.

But, the shorts have to pay interest when they borrow shares, so it costs them money to hold this position while they wait to exit. That means if GameStop starts to go up, they are losing money, paying interest on these borrowed shares.

Here’s where WallStreetBets on Reddit comes into play.

You have a few people that are bullish on GameStop as a company, for a variety of reasons. They think it’s actually a good value play and has a lot of potential to increase in value. They post their due diligence to Reddit, outlining why they are bullish on GameStop. It’s also mentioned how most of Wall Street is bearish on GameStop and are shorting the stock. In fact, for awhile now, short interest has been around or above 100% of the shares available.

The amount of shorts and the bullish news of Ryan Cohen, and an increase of digital sales of 309%, makes this a prime setup for a short squeeze.

Remember, if price goes up, the shorts are losing money. They had to borrow shares at interest and the more the price goes up, the more the shorts are getting squeezed, by having to exit their position for a loss by buying back the shares at a higher price.

When there is such a large short position, that means they need to do a lot of buying to cover their position. This large amount of buying increases the price and makes even more short sellers have to buy to cover their position, making the stock price go up even more.

If stockholders continue to hold shares instead of selling them back to the short sellers, the price can continue to go up and up and up.

So, back to WallStreetBets, where they are known for taking ridiculous risk in an attempt for tendies, or sick gainz, you have thousands of retail traders there buying up shares of GameStop in an attempt to squeeze the shorts.

They have clashed with the short sellers, most notably Andrew Left from Citron Research, who has notably been wrong on his bearish positions many times in the past. It’s essentially a David vs. Goliath story, with retail traders looking to punish Wall Street firms and profit along the way. And, I’m here for it.

Perhaps the most legendary of these redditors is DeepF*****Value, who has been bullish on GameStop for over a year and turned $53,000 in GameStop calls into $11 dollars over 17 months… and he’s still holding.

So, did the short squeeze happen on Friday when the stock shot up over 50%? No, I don’t believe it was.

Gamma Squeeze

You had many of these WallStreetBettors and thousands of other retail traders buying up $60 option calls on GameStop expiring this past Friday. The market makers who create these options contracts either find some other party to take the other side of a trade, or the market makers themselves cover their position by buying shares of GameStop.

But, there aren’t enough shares available for them to properly hedge, so they have to buy it at whatever price they’re able to. So this makes the price go up. The price goes up, so brokerages may then margin call the shorts, meaning the shorts may have to close their position or liquidate other positions to satisfy the broker’s requirements.

Where we currently stand as of close Friday, it still appears that 102.29% of the shares of GameStop are shorted, which means shorts have only started to unwind some of their positions.

This means if retail continues to hold their shares and continue to buy up any call options they can get their hands on, this could really cause a significant squeeze on the shorts.

How high will GameStop go? Obviously, no one really knows. Perhaps the most pertinent example of a short squeeze is Volkswagen in 2008. This has been referred to as the Mother of all Squeezes and caused hedge funds to lose $30 billion dollars. The price shot up from $197 in September to $999 in October.

It’ll be interesting to see how this plays out this upcoming week. As I mentioned, I’m long on GameStop, owning some shares and I may look to add more, depending on how things open on Monday.

Even if a massive short squeeze doesn’t happen, this could also be a decent long-term value play if you believe GameStop can cut the dead weight of it’s brick and mortar and expand their ecommerce revenue. With Ryan Cohen aboard and recent increased demand of game consoles, it does seem there’s hope for GameStop yet.